Tough Times Seen For Sector Funds

Sector funds these days have become something like that kid on the playground who, rumor has it, eats worms. Everyone jeers and laughs when he comes around--and it doesn't matter if the rumors are true.

Most sector funds--from health care to technology to communications--are in the red this year, according to fund researcher Morningstar. The products have, meanwhile, taken lashings from consultants and other pundits after many investors spotted easy money in the funds in years past and then got burned during the markets decline.

"There's no question it's tough times for sector funds," said Steven Witt, managing director of Firsthand Management, which offers what Morningstar rates as the industry's worst-performing communications fund. During 1999 and 2000, when sector funds yielded unbelievably high returns, sectors were the darlings of the fund industry, he said. And now that they have plummeted, people say, "You shouldn't play with those tools; they're too sharp.'"

But some analysts and those who provide sector funds insist the products will again find a place in the industry. Some sector fund companies, including Firsthand, are on the verge of offering more mainstream growth funds to help investors diversify portfolios. And, as the industry languishes in this protracted, flat market, executives seem to be reevaluating just what role sector funds will play when the market recovers.

Geoffrey Bobroff, a well-known fund consultant, said in market downturns such as this, where the products have burned many investors, executives are wondering "Are these things real? Do they have a role? Do they fit someplace in the market?"

"They're fair game to be criticized," Bobroff said of the products. "But is there anything wrong with them? No." The industry will likely embrace the products as a method to insert high-risk growth exposure into portfolios, he said, and sector funds should comprise no more than 10% of a well-rounded portfolio.

"The sector funds are what they are," he said. "If you're selling it as a fund group or a total investment idea, that's wrong. If you are selling it as a way of heading some alpha around a core investment offering idea, that makes sense."

Sector fund companies seem to be thinking the same. Firsthand, for example, filed in July to add five new funds to the six sector funds it currently provides. Two new sector funds will cover the biotech and healthcare industries. The other three will be more diversified growth products, including mid-cap growth and large-cap growth. In addition, a number of sector fund companies are or plan to provide new, diversified products, according to Morningstar.

"It's definitely a trend we've seen," said Bradley Sweeney, an analyst at Morningstar. "Sector-specific funds...are turning to this and trying to gain a foothold with a more diversified growth fund. It's definitely an effort to spread their bets. Just like an individual investor trying to diversify their portfolio (companies) are broadening their product offerings."

Witt, meanwhile, says his firm specializes in growth investing and that's not going to change as the company adds more diversified offerings. He insists that the new products are not a response to the woes of sector funds. "It's just evolution of the firm, which is focused on growth," he said. "It's not a response to anything but a business plan."

He points to the growth of his firm, which skyrocketed from $2.3 million in assets under management when it was founded in 1996 to $8 billion in March of 2000. That growth was followed by a heart-pounding decline to today's figure of $2.6 billion in assets, but it's still a far cry from the firm's humble beginnings, he said.

"Nature cycles," he said. "I think we'll be back. Having not changed what we do, I think people will admire us for that."